How Much Money Can Nonprofits Keep? Understanding Rules and Financial Best Practices

Nonprofits are in a unique position among businesses. They must carefully balance the collection and distribution of funds in order to best pursue their mission. A nonprofit that immediately gives away all of its collected funds will very quickly lose its financial security, and possibly be out of the business.

This leads to a very common question among new nonprofits - how much money are they actually allowed to keep? There is no easy answer here, no number we can give you. However, there are certain legal, ethical and operational considerations that are essential. 

The most essential to understand is that you cannot distribute profits to a disqualified person. This includes any person who is in a position to influence the affairs of the organization, or who could have influenced affairs within the past five years. Surplus funding from the operations of the nonprofit is intended to be reinvested into the mission of said nonprofit. But how much surplus should you keep? That’s what we’ll explore here. 

How the IRS and Government View Nonprofit Surplus Funds

As with most issues of nonprofit compliance, the best place to start is with the IRS, and understanding their position on the matter. There is a wealth of material you need to familiarize yourself with on maintaining the tax-exempt status of your nonprofit. 

The IRS permits nonprofits to generate surplus funds, as long as those funds are then reinvested into activities that support the mission of the organization. The IRS has no issue with profit - rather they have an issue with that profit benefiting individuals, such as your staff or nonprofit board of directors. Beyond actively watching for misuse of your savings account, the IRS may also investigate if your nonprofit starts to hoard or accumulate funds without redirecting them towards the mission. 

State regulations on the matter will vary, but you should expect them to follow the IRS’s lead. This means that your local state government will also be watching to make sure that surplus funds are used appropriately. 

There is also an ethical concern here beyond simply losing tax-exempt status. Your funders and stakeholders will expect your nonprofit to use funds appropriately, and demonstrate this through transparency.

Best Practices for Managing Surplus Funds Internally

So the main takeaway so far is that your surplus needs to be dedicated towards your mission. Of course, that’s still quite a broad prerogative. To avoid any potential complications or doubt, it’s best for your nonprofit to establish a clear set of best practices regarding financial management. Following are some examples of best practices to implement. 

Create a Reserve Policy

It is a prudent move to designate a certain portion of your surplus as a “reserve”. This reserve will serve as a financial safety net during lean times or emergencies. It’s the nonprofit equivalent of putting money away for a rainy day. In order to avoid worries over the size of your reserve, it is best to create an official reserve policy dictating its size. 

Exactly how big a reserve needs to be depends on the nonprofit in question. But, in general, it needs to be able to cover your operations during a shortfall, cover any spending needed for growth, and cover any investments you want your nonprofit to engage in. A good rule of thumb is to have reserves that can cover at least 3-6 months of operating expenses. You should, of course, also set aside reserves for other contingencies - more on that later. 

Build a Compliance Checklist

It goes without saying that your nonprofit should always be adhering to any laws regarding the surplus, be that from the IRS or your state legislators. This means, we must stress again, never using any of the surplus for personal benefits. 

Set Aside for the Future

It is a best practice for not all of the surplus to be used just on daily operations. A portion of the reserve should be used for future-proofing your nonprofit. This can be done by allocating funds to be directed towards capacity building or growth initiatives. These are things like the construction of new facilities, or starting new fundraising programs. 

Evaluate Regularly

Creating a surplus fund strategy can never be a “one and done deal”. Your organization should, every year, revisit your financial statements and see if you need any adjustments to promote better sustainability. For example, if growth is low, perhaps there needs to be more funds allocated to future-proofing. If your emergency fund is often nearly spent, you should consider bolstering your bank account, if only temporarily. 

Consult Financial Experts

Does this bookkeeping seem overwhelming? It’s understandable if it does. But it's your responsibility to always be prepared, no matter how difficult. You can find a lot of great information on proper usage of surplus funds from the IRS. But for the best security, it’s a best practice to work with a nonprofit financial advisor or CPA. They’ll have the expertise to help you manage your cash flow responsibly, and also be able to point out opportunities for investments for growth. 

How Much Money Should Nonprofit Organizations Reserve?

We’ve mentioned before the importance of setting up a nonprofit reserve. However, this is worth some further breakdown to understand, as it is such an essential part of running your nonprofit. It can also prove to be a liability, however, if you use it incorrectly or amass too much in it.

But how much money should be in your operating reserve? The best way to look at this is not to select a single amount or percentage. Rather, break down your reserve into a few distinct parts, and lay out an amount for each. Here’s an example of what your reserve should roughly look like as a guide. 

The Operating Reserve Fund

The Operating reserve refers to the portion of the reserve that is set aside to deal with potential financial fluctuations. Ideally you should have about 3 months worth of funds at least in your operating reserve, and no more than 6.

The Emergency Fund

Many nonprofits will often separate out an emergency fund from the Operating Reserve. This fund is meant to deal with crises, rather than normal financial fluctuations. These could be natural disasters, or severe financial downturns. A decent rule of thumb would be to reserve roughly 10% of your budget in the reserve in case of emergencies. 

The Capital Reserve Fund

The Capital Reserve is a portion of your reserve set aside for significant purchases. This could be anything from equipment upgrades, to a whole new building or location. The Capital Reserve is normally only slowly accumulated once you have an expense in mind, and its size depends on the expenditure at hand. 

Designated Reserve Fund

The Designated Reserve is a similar concept to the capital reserve. It refers to any funds designated for a particular purpose, be that program expansion or special fundraising events. The difference is, these funds aren’t going to be spent on a purchase that increases the nonprofit’s capital. Rather, they’re used for general charitable purposes. 

Risk Management Reserve Fund

The Risk Management Reserve is an offshoot of the emergency fund. Specifically, it’s the portion designed to handle common sources of risk for nonprofits. such as litigation, insurance claims or compliance penalties. 

How to Find More Funds for Your Nonprofit

Having a surplus is always a benefit for a nonprofit organization. If your nonprofit is having to consider what to do with excess funds, that means that your fundraising efforts have been a great success! 

Our database is filled with amazing opportunities for nonprofit organizations, letting you connect with grantmakers and other great sources of funding. Full access to the database comes with GrantStation membership. GrantStation also offers excellent educational resources made by top experts, like our series of webinars. With these, your nonprofit will be empowered with the knowledge and contacts to fundraise in confidence.